Question

Young Co. issues $800,000 of 10% bonds dated January 1, Year 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in five years. The current market for similar bonds is 8%. The entire issue is sold on the date of issue. The following values are given:Present Value ofOrdinary Annuity Present Value of $1---------------- -------------------N=10; i=0.04 8.11090 0.67556N=10; i=0.05 7.72173 0.61391What amount of proceeds on the sale of bonds should Young report?A. $799,997B. $815,564C. $849,317D. $864,884

Answer 1

Answer:

Young should report proceeds from the sale of bonds as equal to $864,884

Explanation:

The proceeds on the sale of bonds is equivalent to the present value of all the cash flows that are likely to accrue to an investor once the bond is bought. These cash-flows are the periodic coupon payments that are paid semi-annually and the par value of the bond that will be paid at the end of the 5 years.

During the 5 years, there are 10 equal periodic coupon payments that will be made. In each  year, the total coupon paid will be

$800,000*0.1= 80,000$

and this payment will be split into two equal payments equal to $\frac{ 80,000}{2} = 40,000$ . This stream of cash-flows is an ordinary annuity

The periodic market rate is equal to $\frac{0.08}{2}=0.04$

The  PV of the cashflows = PV of the coupon payments + PV of the par value of the bond

=$40,000*PV Annuity Factor for 10 periods at 4%+ $800,000*\frac{1}{(1+0.04)^10}$

$= 40,000*8.1109+ 800,000*0.67556= 864,884$